Yes, it’s that time of year again…
But I must confess mixed feelings – for me, a year-end review’s just the annual conclusion to the (auditable) tracking of my ongoing portfolio performance. More generally, though, I suspect it can be disheartening for readers – as with much of the internet, the result’s often exciting at first…but ultimately demoralising. Have a tough year & there’s nothing worse than hearing about other investors chalking up block-buster returns left, right & centre.
But that’s the nature of the beast. Gone are the days when your one & only competitor was that insufferable git down the pub each Xmas, who always boasted he’d bet his chips on yet another ten-bagger (so why’s he still in your boozer?!). But today, we have the internet…now you compete with countless investors across the globe, no matter how experienced, gifted, or born lucky they are! And most laugh in the face of home bias – so inevitably, there’s a multitude who just surfed their killer local market & totally crushed your puny performance, esp. if you were running a sensibly diversified portfolio. Not to mention how little performance can actually be tracked, or who has any real skin in the game – don’t we all start out as great traders/investors, making big bets on paper, much like gamblers always start lucky!?
[And yeah, we all know that Twitter guy who spent all year flailing about, then bounces back with a breathless ‘Up +50% again this year…my leveraged Brexit shorts & US Prez Election longs worked perfectly, bro!’. Um, why are you even reading his tweets?!]
This is not to denigrate some great investors out there, who have clearly delivered spectacular results (& who genuinely appear to owe more to skill than luck). The internet is the problem here – namely, its ephemeral & anonymous nature – how many (tens of) millions of blogs, pages, discussions, user names & identities are abandoned over the years? As for investing, there’s a far more insidious self-selection process…we tend to only ever hear about the best investors (& the best returns). I mean, how many investors just get bored, discouraged, make (the same old) mistakes, lose money, blow themselves up? Who knows – in all likelihood, they’re long gone! The blog posts cease, the messages end, the tweets trail off, they move on (or start afresh)…and that’s precisely why the internet keeps beating you: Survivorship bias.
So, take heart, mes braves – if you really must, evaluate yourself vs. the indices & the fund managers who’ve actually built a long-term track record (through thick & thin). As for the internet, exploit it for data & potential stock ideas…not to beat yourself over the head, or get led astray. Let’s not forget, passive can beat active can beat truly active for long periods (hence the more recent performance of ETFs vs. mutual funds vs. hedge funds)…as frustrating as it can be, it’s important to remember there’s little correlation between the work you put into your portfolio & your actual short-term returns. As they say: In the short run, the market’s a bitch, but in the long run, it’s a weighing machine.
Nonetheless, in the euphoria of a Trump Rally*, many would prefer to forget how grim it was last year. Particularly in Jan/early Feb, when the markets headed straight off a cliff (a wobble in Feb/March this year wouldn’t surprise me either). A subsequent recovery then hit the brick wall of Brexit…though looking back, it’s proved indiscernible on the magnificent +14.4% FTSE trajectory for the year. Of course, many would point to the FTSE’s reliance on international & natural resource companies, but interestingly enough, the AIM Index clocked a near-identical +14.3% return…which certainly appears to confirm a more risk-on attitude. The real damage showed up in the FTSE 250, but it still delivered a modest +3.7% return in the end. Which all goes to show, a sterling crisis always seems to turn out well for the market – though noting the FTSE’s two previous/consecutive years of negative returns, a rally was maybe overdue regardless…
Ireland’s the real Brexit loser, with the ISEQ down (4.0)%. As I’ve discussed before, Ireland’s competitive advantages (plus its underlying economic recovery & momentum), should more than compensate for any potential medium & long-term (hard/soft) Brexit threat to exports & tourism. [And Irish companies have coped with FX volatility for decades now]. However, after an initial false start, an ISEQ rally finally kicked off in Oct, besting its immediate pre-Brexit high by Dec – I see no compelling reason it can’t keep pace with the UK market now. [And after 5 years of consecutive positive gains, this annual decline’s an obvious & perhaps useful pause].
As for Europe, with the Bloomberg European 500 Index down (2.0)%, Brexit seems to have sparked fresh fears of euro withdrawal & dissolution. Which strikes me as a curiously American phenomenon (I’d rate the idea of a euro disintegration as almost equally remote, but nobody ever speculates on a US state reconsidering the buck!?). [Um, so what about this Calexit movement?!] And faintly ridiculous – Brexit’s nothing to do with the euro anyway. While the populist parties of Europe will obviously tar & feather the EU bogeyman for their supporters’ perceived ills, to also blame & repudiate the euro seems like a reach too far (but never say never when it comes to gullible/uneducated voters). In reality, two more states actually joined the Eurozone in the last three years & I fully expect this trend to continue (not reverse). I suspect the European banking system is still the real fear here (with Monte de Paschi & Deutsche two of the biggest/latest wobbles). A decade after a crisis America caused, it’s somewhat galling to see US banks in excellent shape, while so many European banks remain in limbo…somewhere between the US short sharp shock approach & Japanese zombification. [Not to mention the EU/ECB’s obsession with opposing all forms of state-aid].
Finally, we have the booby prize, the US election… A great reminder to never pay attention to the pundits (who totally ignored the omen of Brexit), or even bother trying to time/second-guess the market. Personally, I was cashed-up at the end of summer due to some profit-taking & cleaning house on legacy positions, but also because I anticipated significant Trump (& even Fed) related downside volatility pre & post-election. In the end, a negative Trump reaction never happened (except for a few hours of Uncle Carl time)…so in reality, predicting a (supposed) outlier event is only half the battle. [Fortunately, I averaged in from Sep, and never focused specifically on any #TrumpPicks (rightly, or wrongly), ending up fully locked & loaded by early-Dec]. However, it did occur to me afterwards that the market was ready to rally regardless, it just needed a new narrative…after all, both candidates promised fiscal stimulus (& profligacy)! Which makes sense looking back at the chart – the Trump victory/reaction now looks more like a natural extension of the +9.5% S&P trajectory for the year.
That’s a +4.5% benchmark, which requires no further comment – so let’s hit the main event (except I showed my hand in Nov!), the Wexboy FY-2016 Portfolio Performance, first in terms of individual winners & losers:
[**Exited holdings, except TLI:LN for which I’ve adopted an estimated final NAV, since it’s now delisted/scheduled for a liquidation payment in Jan. Other holdings: Gains are based on average stake size (original yr-end 2015 allocations, except for FIG:US) & year-end 2016 share prices (vs. year-end 2015 prices). NB: Year-end 2015 share price for VOF:LN re-denominated to GBP, to reflect an end-March listing currency change. Otherwise, I specifically exclude all FX gains/losses & regular dividends.]
And ranked by size of individual portfolio holdings:
And again, merging the two tables – in terms of actual portfolio contribution:
Which provides all the gory detail: A (4.6)% loss for the year is actually my worst absolute return since the blog commenced…and also the worst relative return, being a (9.1%) shortfall vs. my benchmark.
Regular readers will note this is marginally worse than my (2.4%) H1-2016 return, so the carnage resulted from the H2 collapse in NWT:LN & ZMNO:ID – in fact, the majority of the portfolio delivered excellent H2 gains. But considering the size of my stake & the resulting negative contribution, the blame lies solely with Zamano (ZMNO:ID). I’ll resist the usual corporate response here – i.e. bunging out some pro-forma table, omitting all the bad bits – though obviously I must highlight my ex-Zamano FY-2016 Return would otherwise have been +7.7%, significantly ahead of my benchmark.
And fortunately, in the real world, things aren’t so grim. As noted in my Nov post, the math works against me: An 11.3% Zamano holding, in relation to the disclosed portion (at 57%) of my entire portfolio, is more like a 20% position when calculating performance here (i.e. the ZMNO collapse hit my blog portfolio twice as hard as my real world portfolio). While my undisclosed (for the moment!) holdings, which are far more biased now towards US & luxury stocks, boast a v different return profile (7.0%+) for the year – while dividends add another few percentage points. Granted, neither source of return is specifically relevant here, but they do tip my real world portfolio return well into positive territory.
Hey, you gotta pay the bills somehow…right!?
Now, in light of this blog performance, I see little point in focusing on winners here (but I raise my glass!) – instead, I’ll hold my nose & perform a brief post-mortem on each of the losers:
The loss is immaterial, but the +14.3% AIM Index gain’s a reminder of the opportunity cost here. Rasmala’s problem has been a negligent return on equity (RoE), with little chance an over-capitalised balance sheet would yield a decent RoE (even if the original operating/AUM targets were met). I also assumed an oil bear market (in the last few years) was irrelevant, as shariah fund management appeared to be a secular growth story, but with the operational disappointments here that became yet another negative influence on a neglected stock. Noting the fundamentals (NAV & AUM essentially unchanged for 3 years now), I assumed a 0.6-0.8 P/B trading range, which was clearly wrong…I never anticipated a 0.2-0.4 P/B range as a new normal here. A major corporate event (takeover, or liquidation) is inevitably required to realise shareholder value, so time remains the enemy…
With a 9.0% total dividend yield (6.9% in terms of base dividend), FIG actually delivered a positive return overall. Over the last few years, AUM’s grown modestly, pre-tax distributable earnings remain steady, while net cash/investments (& gross embedded incentive income) comprise an ever-increasing percentage of FIG’s falling share price…coupled with a 20% reduction in outstanding shares (since end-2013), EV/AUM has become progressively more compelling. However, when it comes to asset management firms, all investors seem to focus on is AUM growth, plus the ongoing switch from active to passive management (despite its basic irrelevance for private equity firms), so the slowdown/halt in FIG’s AUM growth in the past year (or so) has been punished severely. Poor hedge fund performance over the past few years also seems to have (unfairly) tainted the private equity firms, while lingering fears of a fresh bear market has compressed multiples in such a (potentially) high-beta sector…it’s been a painful trend to fight/outlast.
Like many Sum-of-the-Parts investments, Donegal offers a fairly negligible return on equity, with stated NAV unchanged over the last 4 years (after a modest dividend). So while underlying intrinsic value still appears substantially higher, seeing the share price trade down to a modest NAV discount is unsurprising. The major error to date is the assumption management could & would move much faster here to: i) realise & enhance underlying intrinsic value, with the legal acrimony re Donegal’s stake in Monaghan Middlebrook Mushrooms particularly at issue, and ii) restore/expand margins in both the core produce business and non-core speciality dairy & animal feed divisions. Again, time is the enemy here…
Having already identified the electronic division as a millstone, with a decade-long history of stagnant revenue & declining profits, I presumed management would be forced to aggressively rationalise, liquidate, or otherwise dispose of this business. This would have freed up more surplus cash, and just as importantly, re-focused management’s attention on the more valuable (but more volatile) asset protection division. But so far, management’s dug its heels in, continuing to allocate disproportionate time & assets to the electronic division, despite the fact it’s now loss-making (to the tune of £0.5 million). Which I suspect took management’s eye off the ball elsewhere – as a result, NWT now expects a loss this financial year, due to a revenue/profit shortfall in the asset protection division (which hopefully proves a timing/sales pipeline issue ultimately). Despite a cheap market valuation, the share price reaction was exacerbated by the CEO, who’s (laudably) sales-driven, but perhaps not yet experienced enough to actually under-promise & over-deliver…
Who wouldn’t throw their hands up in disgust here… Zamano’s CEO resigned in May – which, at the time, I suspected was ultimately a good thing in terms of strategy, but in reality it’s left an operational vacuum ever since. New initiatives such as Messagehero, new/developing geographic markets & direct carrier billing, all seem to have evaporated. And despite having ‘planned for implementation of Payforit’, shareholders were still blind-sided by a Sep trading update stating it would now have a ‘material adverse impact’ on UK revenues. While I never expected significant operational growth potential here, this reversal still came as a shock – but my primary error was to presume management would actually focus on shareholder value & sensible capital allocation, despite having no real skin in the game…i.e. no vested interest in the current share price. Unfortunately, the same was perhaps true of the major stakeholders, albeit for a different reason – being trapped by the size of their stakes vs. the illiquidity of the shares, a potential exit price was pretty much the only relevant metric for them ultimately. Fortunately, the recent operational debacle appears to have changed all that – the (fruitless) acquisition strategy’s now off the table, the board has slimmed down, and management’s had to come up with a plan to preserve Zamano’s profitability & €7.3 million cash pile (vs. a €6.0 million market cap).
But what’s most notable here, in terms of lessons to be learned, is the fact my major losers of the year were both micro-caps. That’s not to suggest avoiding such stocks in the future, but it does suggest limiting their overall portfolio allocation (bearing in mind they tend to be illiquid). It also re-confirms my current approach…which is to demand a more asymmetric risk-reward from micro-caps (vs. large-caps), to compensate for the increased risk(s). Which has generally served me well over the years in terms of interesting opportunities – not to mention, consistent pricing discipline can hopefully save your ass…
[My ZMNO & NWT losses are actually limited to 25-30% (vs. original entry prices), despite their collapsing share prices – i.e. mostly unrealised gains were incinerated – not a happy state of affairs, but no catastrophe either].
The real risk, I believe, is a creeping confirmation basis: In reality, a micro-cap double is no big surprise, but it can quickly fool you into thinking such stocks are actually resistant to negative surprises, and even have the ability to consistently compound in value & even attain a full (or even excessive) valuation. But in reality, they’re not…any unexpected surprise, no matter how small, is almost inevitably material relative to their size, and in terms of management’s ability to actually deal with it. And the historical record’s bleak – the vast majority of micro-caps stay micro-caps forever. Not to mention, you may face a risk that’s prevalent in so many special/activist situations…things may even have to go (badly) wrong, before management is finally forced to come to its senses & make some rational/shareholder-friendly decisions. Summing all that up, I really have to wonder if an auto-exit after a quick double (one should be so lucky) is perhaps the golden rule when it comes to micro-caps – it certainly would have banked some tasty profits on both ZMNO & NWT, and saved me from their current travails…
Now – for some useful longer-term perspective, let’s wrap up with a table detailing the the last five (calendar) years of blog performance.
[NB: Barclay Hedge Fund Index performance is best estimate as of end-Dec.]
[Again, please note regular dividends are excluded from returns – which hopefully provides a reasonable indication of likely net performance, e.g. after fees (& bid-ask spreads) (and noting a low turnover ratio). Plus most investors tend to compare investment performance vs. price indices, rather than total return indices – another good reason for this approach.]
For an easier recap, let’s redo this table here:
The Wexboy Portfolio has chalked up a +45.5% Total Gain, and a +7.8% CAGR, in the last 5 years. Which looks respectable for a reasonably well-diversified portfolio, run just as much to preserve wealth as to enhance it, particularly noting the low rate/low growth environment in which we now reside. But obviously this performance falls well short of my benchmark, which boasts a +10.8% CAGR…though I’m heartened to see I’m still close to an ex-ISEQ benchmark (perhaps a more appropriate real-world benchmark) (for an +8.4% CAGR), and well ahead of the hedge fund universe (on a +5.8% CAGR).
Again, I lay the blame on Zamano…it’s astonishing a single stock, in a single six month period, can throw off my long-term performance so much!? Ex-Zamano (specifically, in FY-2016), my 5 year performance would otherwise have been a +64.3% Total Gain, and a +10.4% CAGR – pretty much equalling my benchmark. Hopefully, my relative portfolio performance picks up again from here, and we can forget such pro-forma alternatives!
And finally, I can’t resist…take another look at those last tables, have you noticed the incredible divergence in performance for the US vs. Europe (& the UK) over the last 5 years?! On average, the S&P’s racked up well over double the gains of the two lagging indices – is this really sustainable?! Consider the relative position of the US vs. Europe…the same 2.0% Real GDP trajectories in 2015-2016 (contrary to general opinion?), a euro that’s now almost 25% weaker vs. the dollar in just three years (not to mention, pronounced dollar strength & euro weakness across the globe), their current positioning in terms of QE super-cycles (rising rates & no fresh bond buying vs. negative rates & continued bond buying), the more recent US earnings-growth drought, the unpredictability of a Trump regime (though we may also see fresh populist risk in Europe this year), etc. Also consider Europe’s P/E ratio, which has now reached a 35% discount vs. the US, compared to a long-term median P/E which is indistinguishable from the US (a mere 3% discount).
Personally, I’m reminded of Germany at this point. Remember it was labelled the ‘sick man of Europe’ back in the late ’90s – obviously, for specific reasons at the time – but this ultimately heralded (almost inevitably?!) a subsequent golden era of market/economic out-performance. I have to wonder if Europe (um, not just Italy?) is now the ‘sick man of Europe’ itself…as counter-intuitive as that might feel, it’s at least worth pondering whether the region’s finally lining up as a compelling contrarian bet?!